Introduction
In a Federal Court of Australia decision (Australian Securities and Investments Commission v Healey [2011] FCA 717) handed down on Monday 27 June, his Honour Justice Middleton found the CEO, the CFO, the non-executive chairman and five other non-executive directors of the Centro property group (made up of Centro Properties Limited, Centro Property Trust and Centro Retail Trust) in breach of their duties under sections 180(1), 601FD and 344(1) of the Corporations Act 2001 (the Act) in failing to notice multi-billion dollar errors in the group's financial statements.
The 2007 annual reports of two of the Centro companies were in issue - one of which failed to disclose AU$1.5 billion in short-term liabilities and US$1.75 billion in guarantees of short-term liabilities of an associated company, and the other which failed to disclose AU$500 million in short-term liabilities classified as non-current.
was found that the matters that had not been disclosed were, or should have been, well known to the directors and that the directors should not have certified the financial statements and published the annual reports in the absence of the disclosure of these matters, which were of significance to the assessment of the risks facing these companies.
Directors as a 'final filter'
His Honour emphasised the importance of financial statements and the significance of the role of a director as a 'final filter', who must have the financial literacy to understand basic accounting conventions. The necessary diligence required of a director includes a thorough comprehension of the financial statements having regard to the director's knowledge of the company's financial position. His Honour found that a director must be familiar with the fundamentals of the business, be kept informed as to corporation's activities, monitor corporate affairs and policies, regularly review the financial statements so as to be familiar with the financial status of the corporation and maintain a questioning mind.
His Honour also clarified what was expected of a director in forming the opinion required under s 295(4) of the Act as to whether the financial statements complied with accounting standards and constituted a true and fair view of the company's financial position and performance. This included making appropriate enquiries with regard to the magnitude and classification of liabilities and post balance date guarantees and requesting declarations of the CEO or CFO pursuant to s 295A of the Act.
What do sections 180 and 344 of the Act require?
His Honour noted that the standard required of directors is that of reasonable care and skill and does not require perfection. He characterised the interplay between s 180 and s 344 in the circumstances of this case as:
- the directors were required by s 180 to be diligent and careful in their consideration of the resolution to approve the accounts and reports, and
- the directors were required by s 344 to take all reasonable steps to secure compliance with the relevant provisions of the Act, and to at least inquire about any potential deficiency in the accounts and reports that they observed or ought by the exercise of the requisite care and diligence to have observed.
His Honour found that the directors had not complied with these requirements.
Reliance on others inadequate
Three of the non-executive directors sat on the Centro 'Board Audit and Risk Management Committee' (BARMC). The other directors claimed to have relied on the BARMC and advice received from PricewaterhouseCoopers.
It was argued that by setting up these review processes, ensuring that they were undertaken and relying on proper advice, the directors' responsibilities had been discharged. His Honour, however, disagreed, concluding that each director was required to have made a considered individual assessment of the situation. The fact that those advising the directors had fallen into error was irrelevant, according to his Honour, in characterising the directors' conduct.
Implications
Following on from the 2009 James Hardie decision, non-executive directors' duties continue to be clarified. These directors are expected to be knowledgeable about the affairs of the company, be financially literate, understand and comply with the Act and focus their own minds critically to the task of reviewing financial statements and reports which they are required by law to approve and adopt.
This decision clarifies that receipt of advice from management or auditing or accountancy experts does not relieve directors of this duty.
Rejecting the suggestion that ASIC was demanding too high a standard from the directors, his Honour characterised his approach as coming close to 'placing a burden on each director akin to each director having not only to take reasonable steps to secure compliance with the Act, but actually complying with the Act.' He added that he did not regard that obligation as onerous.
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